The past week brought us history: on Tuesday, GETCO and Citadel’s HFT algos were used by the Primary Dealers and the Fed to send the Dow Jones to all time highs, subsequently pushing it to new all time highs every single day of the week, and higher on 8 of the past 9 days: a 5ish sigma event. But there is never such a thing as a free lunch. And here is the invoice: in the past 5 days alone, total Federal Debt rose from$16.640 trillion to $16.701 trillion as of moments ago: an increase of $61 billion in five days, amounting to $198,697,068 for every of the 307 Dow Jones Industrial Average points “gained” this week. Because remember: US debt is the asset that allows the Fed to engage in monetization and as a result, hand over trillions in fungible reserves to banks… mostly foreign banks.

From Debt to the Penny:

The good news is that debt is no longer and issue, and only the level of the stock market matters. Because if the wealth effect at $16.7 trillion and a record DJIA is staggering, just wait until the Obama administration takes the debt to $22 trillion in under 4 years.

At that point, nobody will have ever ever have had more money. Sadly, at some point, all that money will be used to buy a loaf of bread….

Just as Byron Wien publishes his ten surprises for the upcoming year, Morgan Stanley has created a heady list of seventeen macro surprises across all countries they cover that depictplausible possible outcomes that would represent a meaningful surprise to the prevailing consensus. From the return of inflation to ‘Brixit’ and from the BoJ buying Euro-are bonds to a US housing recovery stall out – these seventeen succinctly written paragraphs provide much food for thought as we enter 2013.

 Via Morgan Stanley:

Just When You Thought it Was Dead, Inflation Returns (Joachim Fels/Charles Goodhart)
A strong economic rebound in China and the US, adverse supply shocks in agriculture and worries about swelling central bank balance sheets lead to a sharp rise in actual and expected global inflation. Central banks don’t dare to respond, given high debt levels and financial fragilities, and either continue to ignore or abandon their inflation targets. Rising wheat prices lead to bread riots. In the UK, Chancellor Osborne advises the British to eat oatcakes instead.

Debt Cancellation (Spyros Andreopoulos)
The US Treasury, Japan’s Ministry of Finance and Her Majesty’s Treasury jointly announce that the Treasury debt held by the Federal Reserve, Bank of Japan and Bank of England respectively as a consequence of QE purchases are cancelled, and that these central banks will operate with negative equity until further notice. As a consequence, government debt/GDP ratios are brought down by 11pp, 18pp and 25pp, respectively. Ratings agencies love it, as does the bond market – until it realizes that large-scale debt monetization has just taken place, and sells off sharply.

US Over the Cliff and Likes it (Vincent Reinhart)
The US goes over the fiscal cliff and likes it. A deal delayed to early 2013 in which politicians compromise because of concerns about financial markets would resolve uncertainty more assuredly than the baseline of stop-gap legislation followed by a plan later in the year. As a consequence, confidence gets a boost, pent-up business investment kicks in and the labour market improves more rapidly.

US Housing Stalls Out (David Greenlaw)
The burgeoning housing recovery in the US begins to stall due to credit tightening. There is still no private mortgage market at this point and financial problems are brewing at the FHA which could lead to a dramatic reduction in credit availability for first-time homebuyers. Meanwhile, putback risk continues to cause originators to increase scrutiny for conforming loans. >> Read More

In other words, Bank of America just predicted at least 2 years and change of constant monetization, which would send the Fed’s balance sheet to grand total of just over $5,000,000,000,000 as the Fed adds another $2.2 trillion MBS and Treasury notional to the current total of $2.8 trillion.

It gets worse:

Since the Fed is effectively becoming the marginal player in both the MBS and Treasury markets, a very relevant question is how much private market debt is left to sell. Short answer: not much. According to BofA’s calculation, the Fed will own more than 33% of the entire mortgage market by 2014.

 That’s half the story.

On the Treasury side, in just over 2 years, “Fed ownership across the 6y-30y portion Treasury curve is likely to reach about 50% by end of 2013 and an average of 65% by end of 2014.” You read that right: in just over 2 years, the Federal Reserve will hold two thirds of the entire bond market with a maturity over 5 years (which by then will be part of the Fed’s ZIRP commitment, yield 0% and essentially be equivalent to cash).

And speaking of hyperinflation (and our earlier note that nothing “else is equal”) the real question is if indeed the Fed will own $5 trillion in “assets” in 27.5 months, what does that mean for gold and crude? 

In case it is unclear, the answer is:

• $3350 gold
• $190 oil.

Luckily the Fed has already factored all these soaring input costs (and “alternative money” prices) in its models, and there is nothing to worry about. Lest we forget, the Fed can crush inflation cold in 15 minutes cold… somehow. Even when unwinding its balance sheet would mean sacrificing 30% of US GDP and, let’s be honest about it, civil war.

The latest round of quantitative easing announced Thursday by the Federal Reserve will almost certainly trigger a rating downgrade by Egan-Jones.

Already the rating agency had warned on Wednesday when it affirmed the U.S. rating at AA that “QE3 will likely trigger a negative action.”

Given that the outlook is already negative (AA-), a downgrade to AA- would be a logical next step for the rating agency.

“We are not receiving QE3 positively,” Vice President and co-manager of the ratings’ desk Bill Hassiepen told MNI Thursday, while the fiscal situation is a “nightmare.”

While the Fed is seeking to support economic growth through its quantitative easing, Hassiepen argued that the central bank’s “massive monetization” is instead causing “sluggish to stagnant economic growth.” >> Read More

MY TAKE ON EUROPE

Europe is a mess, politically, economically, and fiscally. LTRO gave a short lifeline and at the same time bound the ties even more tightly between bank balance sheets and government bond performance. For all the backslapping, LTRO was a failure, pure and simple. Just as QE — for if QE had been a success, nobody would be looking for a third round (more like the fourth).

I fail to see how any country is going to be able to “grow” their way out of their deficits, barring ECB debt monetization or via German acceptance of a common fiscal policy, which would then allow profligate sovereigns to ride off of Germany’s strong balance sheet. The problem is that the German economy is starting to soften, and along with that I expect polls to start showing lesser support for providing backstops to the periphery. And from a geopolitical standpoint, an ever-isolated Germany spells even more instability. Gold and the gold mining stocks should be a beneficiary.

In less than two years, we are now up to a total of seven European leaders or ruling parties that have been forced out of office, courtesy of the spreading government debt crisis — tack on France now to Ireland, Portugal, Greece, Italy, Spain and the Netherlands. Even Germany’s coalition is looking shaky in the aftermath of the faltering state election results for the CDU’s (Christian Democratic Union) Free Democrat coalition partner.

This is quite a potent brew — financial insolvency, economic fragility and political instability.

Now we have governments, led by Mr. Hollande, who want to adopt “growth agendas” at a time when eroding credit quality is increasingly impeding fiscal borrowing capacity. The French vote comes quickly on the heels of the Dutch government collapse and is joined by a fractious election result in Greece. Germany and other pro-austerity/structural reform entities are the big losers. Then again, how cash-strapped sovereigns who need Germany’s comparatively strong financial position embark on this new anti-fiscal-probity drive is an interesting question.
More uncertainty, more volatility, more risk-aversion likely lies ahead — and along with it, a further deterioration in government financial strength.
As it stands, globally, since the time the Great Recession took hold in 2008, we have seen the total value of government debt backed with AAA-ratings decline from over a 50% share of total outstanding sovereign credit to less than 10%. Quality is scarce, and as such should be owned.

In sum, this is not the backdrop for sustained risk-on investment behaviour. Both Bob Farrell and Walter Murphy see the current corrective phase in the market being extended over the near and intermediate term. I’m not sure I’d want to bet against them, even if Mike Santoli in Barron’s and Paul Lim in the Sunday NYT are advocating a “buy the dips” strategy.

In terms of scouring the globe for countries that are currently being rated AAA by all three agencies, here they are: >> Read More

Summary of the yawn-inducing minutes via Bloomberg:

• SEVERAL ON FOMC FAVORED CHANGE TO MID-2013 RATE VOW BEFORE LONG
• FOMC SAID GLOBAL FINANCIAL STRAINS POSE `SIGNIFICANT’ RISK
• FED PLANS TO RELEASE OFFICIALS’ FED FUNDS RATE FORECASTS (this is not news, and if the Fed is as accurate in “predicting” – note not setting – FF rates as it is in forecasting everything else, woe is us)
• FOMC MEMBERS SAW LONG-TERM INFLATION EXPECTATIONS AS STABLE
• FOMC MEMBERS SAW ECONOMY `EXPANDING AT A MODERATE RATE’
• FOMC MEMBERS SAID CONSUMER SPENDING `STRONGER THAN EXPECTED’
• MOST FOMC MEMBERS PREDICTED INFLATION WOULD `MODERATE’
• ‘A NUMBER’ OF FOMC MEMBERS SAW POSSIBLE NEED FOR MORE EASING

And this is how the Fed will present QE in advance just so Bernanke can hike stock markets purely on expectations and not on actual monetization: >> Read More

Socgen Patience – Bad News Will Become Good News

SocGen Sees $600 Billion QE3 Starting In March 2012 Sending Gold Up Between $1900 And $8500/Oz

SocGen has released its much anticipated Multi Asset Portfolio Scenario/Strategy guide titled simply enough “Patience: bad news will become good news“ >> Read More

Over the past few days, Italy has promptly re-emerged as a main cog in the illusion that Europe is a well-greased machine (yes, we know, funny) after it became clear that the country continues to refuse to implement any actual austerity measures following the requirement to do just that months ago when it got access to the ECB’s sterlizied bond monetization scheme. In fact it got so bad that yesterday the entire Italian governmentwas rumored to be on the verge of collapse as it was once again unable to reach a resolution on what the EU demands are prompt actions taken to raise pension and/or retirement age. According to the Telegraph, Italy may have found a compromise, one which actually ends the regime of Berlusconi… but not yet. Telegraph reports that Silvio Berlusconi has reportedly drawn up a “secret pact” under which he will resign in December or January, paving the way for Italy to elect a new government in March. “The embattled prime minister made the deal with his key coalition ally, Umberto Bossi of the devolutionist Northern League, in return for Mr Bossi’s support for pension reforms, according to unconfirmed reports in two Italian newspapers – La Repubblica and La Stampa. Italy is under huge pressure from the European Union to reform its pensions system and extend retirement ages as part of a plan to rein in its enormous public debt and revive its moribund economy.” “Don’t make a fool of me in Brussels, and I promise that we’ll go to elections in March,” Mr Berlusconi told the Northern League leader, according to La Repubblica.” This would all be great, if only for one small snag: the “plan”, like everything else in Europe, is worthless. The FT reports that the compromise agreement “lacks specifics and risks falling short of what eurozone leaders have demanded ahead of Wednesday’s summit in Brussels….In the end, Umberto Bossi, the fiercely eurosceptic leader of the federalist League, made minor concessions that would raise the general retirement age to 67 years by 2026, but rejected changes to Italy’s length of service pension system that allows many workers to retire at the age of 61 with 35 years of contributions. Even Mr Bossi did not sound hopeful that the proposals would go down well in Brussels. In the past he has said he “doesn’t give a damn” about pressure from Europe over Italy’s pension system.” He may change his tune once BTPs drop under 90 and go bidless.

In the meantime, the political atmosphere in Italy is about to go from bad to worse:

  >> Read More

Dow Jones just hitting the tape referencing Spiegel

• German Govt: Italy Too Big For EFSF To Save – Spiegel
• German Govt: Doubts Whether Tripling EFSF Would Help It Save Italy
• German Govt: Italy Must Make Savings, Reforms To Exit Crisis – Spiegel
• Italy Debt Guarantee Could Raise Doubts Over Germany’s Finances – Spiegel
• German Govt: EFSF Should Only Help Small, Mid-Size Countries – Spiegel

As a reminder, yesterday’s stopgap announcement by the ECB to expand its SMP purchases of secondary market Italian and Spanish bonds was merely as a precursor to full EFSF monetization until its comes fully online in September (or sooner) in a vastly expanded format (between €1.5 and €3.5 trillion).

If Germany is now against this, which appears to be the case, it pretty much means, well, game over.

Add the uncerainty over the unwind of the Europe rescue “gamechanger” as one of the more naive CNBC anchors said yesterday, and Monday is now guaranteed to be a bloodbath.

As for those saying China will gladly step in and fund a $5 trillion EFSF shortfall, they may want to read the following article from Reuters: >> Read More